NORWEST BANK WORTHINGTON AND FEDERAL LAND BANK OF ST. PAUL,
PETITIONERS V. JAMES R. AHLERS AND MARY M. AHLERS
No. 86-958
In the Supreme Court of the United States
October Term, 1986
On Petition for a Writ of Certiorari to the United States Court of
Appeals for the Eighth Circuit
Brief for the United States as Amicus Curiae
This brief is submitted in response to the Court's invitation to
the Solicitor General to express the views of the United States.
TABLE OF CONTENTS
Questions presented
Statement
Discussion
Conclusion
QUESTIONS PRESENTED
1. Whether an undersecured creditor's entitlement to "adequate
protection," during reorganization proceedings, against declines in
the value of its interest in the debtor's property, and against the
"opportunity cost" of not being able to reinvest the value of that
interest, begins immediately on filing of its claim or on the later
date when, under state law, the creditor could have received the
proceeds of a foreclosure sale of the property.
2. Whether the rule allowing a debtor in reorganization to overcome
the absolute priority of creditors by contributing needed fresh
capital may be satisfied by treating an individual debtor's "labor,
experience, and expertise" as the equivalent of fresh capital.
3. Whether 28 U.S.C. 46(c) requires a court of appeals to grant
rehearing en banc when five judges vote in favor of rehearing en banc,
four vote against, and one is recused.
STATEMENT
1. This case arises from the bankruptcy petition of respondents
James and Mary Ahlers. Respondents farm land in Nobles County,
Minnesota. Between 1965 and 1982 they obtained four loans from
petitioner Federal Land Bank of St. Paul (FLB) and secured each of
those loans with a separate parcel of land that they owned (Pet. App.
A3). Between 1982 and 1984, respondents obtained additional loans
from petitioner Norwest Bank Worthington (Norwest). The security for
those loans was a second mortgage on the parcels already securing
FLB's loans and a first mortgage on respondents' farm machinery, farm
equipment, crops, livestock, and other farm proceeds. Id. at A4.
Respondents defaulted on their loans. Norwest, exercising its
rights as a secured creditor, filed a replevin action in Minnesota
state court seeking possession of respondents' farm equipment and
machinery (Pet. App. A4). Two weeks later, respondents filed a
petition for reorganization under Chapter 11 of the Bankruptcy Code,
11 U.S.C. (& Supp. III) 1101 et seq. (Pet. App. A4-A5). This petition
automatically stayed Norwest's collection efforts in state court (11
U.S.C. (& Supp. III) 362(a)).
2. a. Petitioners filed motions in bankruptcy court for relief from
the automatic stay, see 11 U.S.C. (& Supp. III) 362(d), asserting that
respondents could not provide them adequate protection. The
bankruptcy court granted both motions. FLB had requested relief from
the stay in order to foreclose on two of the four parcels that secured
respondents' outstanding loans. The loans that those two parcels
secured were in default, and FLB claimed that the value of those
parcels was significantly less than respondents' outstanding
obligations. The bankruptcy court, after hearing conflicting
testimony on the value of this land, concluded that the current value
of those two parcels did not approach the outstanding balances on the
loans that they secured. The court held that in these circumstances
FLB was entitled to either adequate protection against the
"opportunity cost" of not being able to foreclose its mortgage and
reinvest the proceeds or, in the absence of such protection, relief
from the stay so that those state-law rights could be pursued. Pet.
App. A62-A63. Because respondents had not suggested any means for
providing adequate protection, the court concluded that only periodic
payments of interest would maintain the value of FLB's interest in its
collateral (id. at A63). Respondents admitted that they could not
make such payments, and the bankruptcy court accordingly granted FLB
relief from the stay (id. at A63-A64).
The bankruptcy court also granted Norwest's motion for relief from
the automatic stay. Although the value of the collateral securing
Norwest's claims had exceeded the amount of those claims when the
bankruptcy petition was filed, the court determined that the value of
the collateral had since decreased so that it was now less than
Norwest's claims (Pet. App. A65-A66). Thus, like FLB, Norwest was
undersecured and entitled to adequate protection. Respondents had
offered Norwest a lien on their anticipated 1985 crops, but the court
held that such a lien could not provide adequate protection (id. at
A66 n.9). Thus, as with FLB, Norwest could be provided adequate
protection only through periodic payments, which respondents admitted
they could not provide. Accordingly, the bankruptcy court granted
Norwest's motion to lift the automatic stay. Respondents appealed
this decision to the district court.
b. The district court denied respondents' motion to stay
petitioners' collection efforts pending its resolution of the appeal
but agreed to enjoin petitioners from initiating any foreclosure
proceedings pending appeal of the denial of the stay motion to the
court of appeals. The court of appeals issued a stay and remanded the
case to the district court for adjudication of respondents' appeal
(Pet. App. A75-A77). In so doing, the court noted that respondents'
1985 crops were not subject to any liens and that those crops "have a
value sufficient to reasonably insure that neither creditor will be
further harmed if foreclosure and repossession proceedings are stayed"
(id. at A76). The court gave petitioners a lien on those crops,
stayed any further collection efforts, ordered respondents to provide
Norwest with assurances that all farm machinery and equipment was
fully insured, and requested that the district court determine the
merits of the case, including the probability of success of
respondents' proposed plan of reorganization (id. at A76-A77).
c. The district court affirmed the bankruptcy court's order
granting petitioners relief from the automatic stay. The court
upheld, as not clearly erroneous, the bankruptcy court's finding that
FLB was undersecured on the two parcels of land on which it sought
foreclosure. Because repondents had not offered any means of
providing FLB with adequate protection, the court agreed with the
bankruptcy court that FLB was entitled to relief from the stay. Pet.
App. A84-A85. The court also affirmed the bankruptcy court's findings
that Norwest was under-secured and that the existing crops could not
provide Norwest with adequate protection, as well as the bankruptcy
court's order lifting the automatic stay (id. at A85-A86).
Pursuant to the instructions of the court of appeals, the district
court then evaluated the likelihood of success of respondents'
proposed plan of reorganization. The court found that no such
likelihood existed. Three facts doomed any chance that respondents
would have of successfully reorganizing: respondents had an
asset-to-liability ratio of .67 to 1, they had "failed to establish
their ability to operate profitably in the future," and American
farmers in general face oppressive economic conditions that are
unlikely to improve soon. Pet. App. A87.
3. a. The court of appeals reversed the bankruptcy court's order
granting petitioners relief from the automatic stay. The court stated
that the purpose of adequate protection is, "as nearly as possible
under the circumstances of the case, (to) provide the (secured)
creditor with its bargained-for rights" (Pet. App. A7). The court
held that this compensation can include payment for the lost
opportunity to reinvest the proceeds of a foreclosure sale, and it
refused to overturn the bankruptcy court's determination that such
payments were appropriate in this case (id. at A9). The court of
appeals held, however, that the lower courts had erred in determining
the time as of which adequate protection should begin.
The court of appeals held that adequate protection payments should
begin only after the time when a secured creditor would have realized
the proceeds of foreclosing on the collateral if the debtor had not
filed a bankruptcy petition. The court reasoned that those payments
are compensation for abridgment of the secured creditor's
bargained-for right to foreclose on the collateral in the event of
default, liquidate the collateral, and reinvest the proceeds (id. at
A9-A10). Thus, the court found it necessary to determine "the date
when the creditor, absent the filing of a bankruptcy petition, could
have taken possession of the collateral under state law and could have
sold it to a third party, the amount that the creditor would have
realized at this sale, and the creditor's expected return upon
reinvestment" (id. at A10).
Applying these principles, the court determined that neither
petitioner was immediately entitled to payments on its security
interests in respondents' farmland. The court based this holding on
the provisions of Minnesota foreclosure law. Under this law, a notice
must be published six weeks before a forced foreclosure sale of
farmland (Pet. App. A11). State law also allows the mortgagor a
12-month redemption period following a foreclosure sale, during which
he is entitled to possession, rents, and profits of the land (ibid.).
This redemption period, the court reasoned, would make it "extremely
unlikely that a third party would purchase the property at the
foreclosure sale" (ibid.). Thus, were petitioners to exercise their
state-law right to foreclose, the probable outcome would be that
petitioners would purchase the property at the foreclosure sale and,
after the 12-month redemption period had expired, sell the property to
a third party (id. at A12). Under this scenario, petitioners would
not receive (and could not reinvest) any proceeds from respondents'
farmland until one year and six weeks after they began the foreclosure
proceedings. The court therefore ruled that adequate protection
payments for petitioners' security interests in respondents' farmland
should not begin until 13 1/2 months after respondents filed for
bankruptcy (ibid.).
The court concluded, on the other hand, that Norwest was entitled
to immediate adequate protection payments for its interest in
respondents' personal property. Again the court turned to state law.
Minnesota law allows creditors such as Norwest to take possession of
personal property promptly after default unless the debtors were
dependent on such property for their living. To the extent that the
debtor is dependent on particular personal property, he can retain it
only if he insures it and makes periodic payments to the creditor
(Pet. App. A12). In other words, in the absence of a bankruptcy
proceeding, Norwest could have immediately obtained either its
collateral or periodic payments. In these circumstances, the court
held that adequate protection payments for this property should begin
as soon as Norwest applied for such payments. The court held that
Norwest was also entitled to immediate adequate protection payments
for its interest in respondents' stored grain and livestock because
such assets could be liquidated quickly (ibid.). /1/
b. The court then addressed petitioners' argument that the
automatic stay must be lifted because of the district court's finding
that respondents' proposed reorganization was not feasible. Section
362(d)(2) of the Bankruptcy Code, 11 U.S.C. (& Supp. III) 362(d)(2),
requires a court to lift the automatic stay if the debtor has no
equity in the property on which the creditor seeks to foreclose and
the property is not necessary to an effective reorganization. All
agreed that respondents have no equity in their property, and
petitioners argued that, because respondents have no likelihood of an
effective reorganization, it follows that none of their property could
be necessary to a reorganization. The court agreed that, if a
reorganization was not feasible, the stay should be lifted (Pet. App.
A15). The court, however, reversed the district court's finding that
there was not a reasonable likelihood of a successful reorganization.
The court concluded that the district court erred in using, for this
purpose, the valuation determinations that the bankruptcy court had
made in ruling on the adequate protection issue. Rather, the court
held that the valuation had to be based on the likely value of the
property at the time that the plan would be confirmed (id. at A16).
The court, in dictum, opined that respondents could indeed propose a
feasible reorganization plan (id. at A17-A19, A37-A49).
The court next rejected petitioners' contention that their
legitimate objections to the plan would preclude any successful
reorganization. Petitioners argued that, because their claims were
drastically undersecured, any plan of reorganization would have to
treat them as unsecured creditors for this portion of their claims
(see 11 U.S.C. 506(a)). Further, they said, the plan proposed by
respondents did not provide for full payment of those unsecured
claims, yet it allowed respondents to retain an interest in the farm.
Thus, petitioners argued that the plan did not satisfy the absolute
priority rule embodied in 11 U.S.C. (& Supp. III) 1129(b) and could
not be confirmed over their objections. /2/
The court, however, disagreed with petitioners' interpretation of
Section 1129. It interpreted that section as applying a "modified
version of the traditional absolute priority rule" (Pet. App. A22),
under which respondents' plan could be affirmed over petitioners'
objections so long as respondents retain an interest that does not
exceed the future value of their "labor, experience, and expertise"
(id. at A26). The court relied on this Court's decision in Case v.
Los Angeles Lumber Products Co., 308 U.S. 106 (1939), which it read as
allowing a debtor to participate in a reorganization so long as he
"contributes to the reorganization enterprise something that is
reasonably compensatory and is measurable" (Pet. App. A24). The court
then reasoned that respondents' promise of future labor met this
requirement, and respondents could retain an equity interest in the
property equal to the value of their labors.
c. Judge Gibson dissented. He took issue with the majority's
rejection of the district court's findings that petitioners were
entitled to adequate protection payments beginning immediately. He
argued that the appellate court could only review such determinations
under the clearly erroneous standard and concluded that the record
adequately supported the district court's findings. Pet. App.
A28-A30.
Judge Gibson also faulted the majority's interpretation of Los
Angeles Lumber. He read that opinion as allowing debtor participation
in a reorganization only when the debtor contributes cash or
contributions "distinctly capital in nature" (Pet. App. A34). Judge
Gibson argued that, because respondents' labor clearly did not fall
within this narrow exception to the absolute priority rule, the plan
could not be confirmed (id. at A34-A35).
4. Of the 10 judges in regular active service on the court of
appeals, five voted in favor of rehearing en banc, four voted against,
and one rescued himself (Pet. App. A51-A58). Because the five votes
did not constitute a majority of the 10 active judges, rehearing en
banc was denied. See 28 U.S.C. 46(c); Fed. R. App. P. 35(a); 8th
Cir. R. 16(a). Four of the five judges who voted for rehearing en
banc joined an opinion that labeled the cour's ruling on the absolute
priority issue "directly contrary to * * * Los Angeles Lumber," noted
that, "in some future case, there may be sufficient votes to enable
this court to revisit the issue," and expressed the hope that this
Court would grant certiorari (Pet. App. A54-A55). The other
dissenting judge expressed tentative agreement with the panel dissent
(id. at A54).
DISCUSSION
The petition in this case raises three issues. One of those issues
is insubstantial, /3/ but the other two, the "adequate protection" and
"absolute priority" issues, touch on important matters that may well
deserve this Court's review in an appropriate case. There is
disagreement among the courts of appeals about what constitutes
"adequate protection," with one court of appeals maintaining that the
debtor need only protect the value of the secured creditor's
collateral, two holding that truly adequate protection must also
include compensation for the lost opportunity of realizing a return on
the proceeds that would have been generated at a foreclosure sale, and
the court below leaving the issue to case-by-case resolution. The
proper scope of the absolute priority rule, on the other hand, has
generated little debate over the years, since the governing rules were
clearly set out in Case v. Los Angeles Lumber Products Co., supra --
from which the court below took a marked departure. If the approach
to absolute priority taken by the court of appeals in this case were
to proliferate, the debtor-creditor relationship would be
fundamentally and unjustifiably altered. On this issue, the Court may
wish to consider summary reversal.
We nevertheless believe that, if the Court is not disposed to
reverse summarily, it should deny certiorari. As to adequate
protection, the important "opportunity cost" issue is not actually
presented by the petition, as the resolution below was favorable to
petitioners. What was determined unfavorably to petitioners was the
timing of adequate protection payments. Although we believe that the
court of appeals inadequately analyzed this issue, the timing issue is
not the subject of any conflict among the courts of appeals and does
not warrant review before further development of the matter in the
lower courts. As to the radical departure by the court of appeals
from settled principles of absolute priority, we regard the decision
below as an aberration that is unlikely to be followed elsewhere and
may not even survive for long in the Eighth Circuit. Moreover,
Congress has substantially amended the Bankruptcy Code's provisions to
offer relief to family farmers. The impact of the decision below is
therefore uncertain.
1. Section 362(d)(1) of the Bankruptcy Code, 11 U.S.C. (& Supp.
III) 362(d)(1), entitles a party with an interest in property of the
debtor to relief from the automatic stay if the debtor does not
provide him with "adequate protection." Section 361 defines how such
protection may be given: through periodic payments that reimburse the
creditor for decrease in the value of his interest in the collateral
caused by, among other things, the automatic stay (11 U.S.C. (Supp.
III) 361(1)), by granting the creditor additional liens to compensate
him for this decrease (11 U.S.C. 361(2)), or by "granting such other
relief * * * as will result in the realization (by the creditor) of
the indubitable equivalent of (the creditor's) interest in such
property" (11 U.S.C. 361(3)).
Courts have split over the meaning of this definition of "adequate
protection." All courts agree that, in order to prevent the automatic
stay from being lifted, a debtor must protect an undersecured creditor
from any decrease over time in the value of the collateral. See,
e.g., In re Timbers of Inwood Forest Associates, 808 F.2d 363 (5th
Cir. 1987) (en banc), reinstating 793 F.2d 1380 (1986), petition for
cert. pending, No. 86-1602; Grundy National Bank v. Tandem Mining
Corp., 754 F.2d 1436 (4th Cir. 1985); In re American Mariner
Industries, 734 F.2d 426 (9th Cir. 1984). They disagree, however,
about whether "adequate protection" also requires the debtor to
compensate the creditor for the lost opportunity to earn a return by
selling the collateral and investing the proceeds. Two courts of
appeals, ruling in favor of such compensation, stress that the purpose
of adequate protection is to give the secured creditor the "benefit of
his bargain" by placing him in the same financial position he would
have been in but for the bankruptcy petition. See Grundy National
Bank v. Tandem Mining Corp., supra; In re American Mariner
Industries, supra. /4/ Another court of appeals, opposed to this
compensation, relies on the congressional desire to facilitate
reorganizations. See In re Timbers of Inwood Forest Associates,
supra; see also In re South Village, Inc., 25 Bankr. 987 (Bankr. D.
Utah 1982). /5/ The Eighth Circuit has taken a middle road, holding
that the appropriateness of lost opportunity costs should be
determined on a case-by-case basis. In re Briggs Transp. Co., 780
F.2d 1339 (1985). /6/
The petition, although it discusses this issue and describes the
circuit conflict, does not present this question. The court of
appeals upheld the bankruptcy court's ruling that petitioners should
receive compensation for opportunity cost. Petitioners, who benefit
from that holding, are obviously in no position to challenge it.
Respondents have chosen not to challenge it (see Br. in Opp. 12), have
not cross-petitioned, and have not asked for the more favorable rule
of In re Timbers.
The issue that petitioners legitimately place before the Court
concerns the timing of adequate protection payments. The court of
appeals said that the purpose of adequate protection payments is to
ensure that the secured creditor is left in the same position as he
would have been in outside of bankruptcy. The court then looked to
Minnesota law and delayed the start of adequate protection payments
until the date on which petitioners could have realized the proceeds
of sale of the secured property through foreclosure proceedings under
state law.
The matter is more complex than the opinion of the court of appeals
would suggest. In instances in which the Chapter 11 proceedings do
ultimately lead to successful reorganization, the delay in providing
adequate protection does parallel the delay imposed by state law
before a creditor may enjoy the use of the property; even in those
instances, there is nevertheless a question whether federal law should
be interpreted to parallel state law in this respect. /7/ In
instances in which the automatic stay is eventually lifted or the
reorganization effort ultimately fails and the creditor must then
proceed under state law, however, the problem is different: a
creditor who has already suffered a "foreclosure delay" before
obtaining adequate protection in reorganization may suffer another
delay of equal duration before he obtains foreclosure proceeds. See
In re Roberts, 63 Bankr. 372, 381 (Bankr. E.D. Mich. 1986) (expressly
rejecting reasoning of decision below for this reason); see also In
re Blackford Farms, Inc., 68 Bankr. 639, 642 (Bankr. N.D. Iowa 1986)
(recognizing this problem); In re Mazama Timber Products, Inc., 63
Bankr. 280, 287-288 (Bankr. D. Or. 1986) (requiring immediate adequate
protection payments but attempting to discern value of property after
anticipated 20-month foreclosure delay); In re Independence Village,
Inc., 52 Bankr. 715, 730-731 (Bankr. E.D. Mich. 1985); In re Bear
Creek Ministorage, Inc., 49 Bankr. 454, 458 n.9 (Bankr. S.D. Tex.
1985) (recognizing problem but imposing delay anyway), rev'd on other
grounds sub nom. In re Timbers of Inwood Forest Associates, 793 F.2d
1380 (5th Cir. 1986) and 808 F.2d 363 (5th Cir. 1978) (en banc),
petition for cert. pending, No. 86-1602. /8/ The analysis of the
court of appeals fails to take account of this important complicating
factor.
Nevertheless, this issue does not, in our judgment, warrant review
by this Court at this point. The courts of appeals have as yet
devoted little attention to the impact of foreclosure delays on
adequate protection. Though both subject to the same criticism as the
decision below, the other two appellate decisions on point are
consistent with the decision below. See Grundy, 754 F.2d at
1440-1441; American Mariner, 734 F.2d at 435 n.12. In addition, the
particular state law that gives rise to the delay in this case,
protecting farmers, is rendered less significant by federal
legislation changing the Bankruptcy Code, as described below. /9/
Accordingly, we suggest that the Court defer consideration of this
issue to allow further development in the lower courts.
2. Section 362(d)(2) of the Bankruptcy Code provides for lifting
the automatic stay when the debtor has no equity in the property
sought to be removed from the stay's protection and that property is
not necessary for a successful reorganization. Courts have held that
this second requirement is satisfied if the creditor seeking relief
from the stay shows that, even with the property the creditor seeks,
the debtor could not successfully reorganize. See, e.g., In re Albany
Partners, Ltd., 749 F.2d 670, 673 n.7 (11th Cir. 1984); In re
Craghead, 57 Bankr. 366, 370 (W.D. Mo. 1985). Here, it is undisputed
that respondents have no equity in the collateral. Petitioners
asserted that they would legitimately object to and block any proposed
plan of reorganization and that therefore they should be relieved from
the automatic stay.
The Bankruptcy Code provides that a plan can be confirmed over a
creditor's objection if the plan is "fair and equitable" to the
objecting creditors (11 U.S.C. 1129(b)(1)). If the objecting group of
creditors is unsecured, /10/ a plan is "fair and equitable" as to them
only if they are paid in full (11 U.S.C. 1129(b)(2)(B)(i)) or if no
junior interests participate in the reorganization (11 U.S.C. (Supp.
III) (1129(b)(2)(B)(ii)). This requirement is the statutory
embodiment of the absolute priority rule. /11/
Although the plan that respondents proposed did not meet either of
the statutory tests, the court of appeals held that the plan could
nevertheless be confirmed. The court read this Court's opinion in
Case v. Los Angeles Lumber Products Co., supra, as allowing
participation by a junior interest even if senior interests are not
paid in full, so long as the junior interest "contributes to the
reorganization enterprise something that is reasonably compensatory
and is measurable" (Pet. App. A24). Respondents had promised to
contribute their labor to any reorganized enterprise, and the court
held that this promise allowed them to retain an equity interest in
their farm up to the value of this promise.
As the dissenting members of the court of appeals recognized, that
interpretation of Los Angeles Lumber directly conflicts with this
Court's opinion in that case. Los Angeles Lumber strongly reaffirmed
the principle that "'creditors are entitled to priority over
stockholders against all the property of an insolvent corporation'"
(308 U.S. at 116 (quoting Kansas City Terminal R.R. v. Central Union
Trust Co., 271 U.S. 445, 455 (1926)). The Court did hold that, at
times, it will be "necess(ary to permit) the inclusion of stockholders
on payment of contributions, even though the debtor company was
insolvent" (308 U.S. at 117). But the Court made it clear that such
participation is permissible only when it is necessary to preserve
going-concern value and the interests of creditors are protected. The
Court said such participation is permissible only if the old
stockholders are the only available source of capital to keep the
reorganized corporation operating (id. at 117, 121). Even then, the
Court was concerned that "the creditor's rights (not) be easily
diluted by inadequate contributions by stockholders" (id. at 122).
Thus, the Court stated (ibid.):
In view of these considerations we believe that to accord
"the creditor his full right of priority against the corporate
assets" where the debtor is insolvent, the stockholder's
participation must be based on a contribution in money or in
money's worth, reasonably equivalent in view of all the
circumstances to the participation of the stockholder. /12/
The Court illustrated the narrowness of the exception by refusing
to apply it to the facts of Los Angeles Lumber. The former
shareholders argued that their participation in the new corporation
was appropriate even though not all creditors were paid in full on the
ground, among others, that they were contributing their financial
standing in the business community. The Court held that such
"intangibles" simply could not be used to overcome the absolute
priority rule. "They have no place in the asset column of the balance
sheet of the new company. They reflect merely vague hopes or
possibilities." 308 U.S. at 122-123.
Since Los Angeles Lumber, no other court of appeals has suggested
that an equity holder can participate in the reorganization of an
insolvent debtor without at least contributing new capital that is
necessary to the reorganization of the insolvent enterprise. See,
e.g., In re U.S. Truck Co., 800 F.2d 581, 588 (6th Cir. 1986) ("If
(the debtor) were retaining an interest without contributing any
capital, the plan would clearly violate the Code."); In re Potter
Material Service, Inc., 781 F.2d 99, 101 (7th Cir. 1986) ("An
equity-interest owner may retain an interest in the debtor corporation
so long as the owner invests new capital into the corporation."); In
re Muskegon Motor Specialties, 366 F.2d 522, 525 (6th Cir. 1966).
Judge Friendly summed up the necessity that old shareholders
contribute new capital before participating in a reorganized debtor:
"(I)t is hard to see why (the unsecured creditors) should not reap the
entire gain if the gamble succeeds, rather than allow the stockholders
to have what is essentially a free ride." SEC v. Canandaigua
Enterprises Corp., 339 F.2d 14, 21 (2d Cir. 1964).
The interpretation of Los Angeles Lumber by the court of appeals
departed from this common wisdom. The court sanctioned participation
of junior interests so long as they contribute "something that is
reasonably compensatory and is measurable" (Pet. App. A24). Thus, the
court treated as an acceptable contribution not only capital with
present value but the mere promise of future performance, so long as
the promise has a determinate value. The court also eliminated the
requirement that the contribution be necessary to a successful
reorganization. /13/ Its holding and this Court's previous decisions
are in irreconcilable conflict. If the law seems as clear to the
Court as it seems to us, the Court may wish to consider summary
reversal.
If the Court views the matter otherwise, however, plenary review is
unwarranted at this time. Bankruptcy law is in a state of flux.
Congress, in response to needs of the family farmer, has recently
amended the Bankruptcy Code by adding a special Chapter 12 to deal
with the unique problems that confront such debtors. See Bankruptcy
Judges, United States Trustees, and Family Farmer Bankruptcy Act of
1986 (1986 Act), Pub. L. No. 99-554, Section 255, 100 Stat. 3105-3114.
Indeed, the new Chapter 12 appears to be more favorable to farmers
than the court's opinion in this case. /14/ Under the new law, a
farmer can retain the equity interest in his land even if unsecured
creditors go unpaid so long as the plan provides that the debtor's
disposable income for three years is used to make payments under the
plan. 100 Stat. 3111 (to be codified at 11 U.S.C. 1225(b)). /15/ If,
as Judge Gibson thought (Pet. App. A35-A36), the court ignored settled
law in order to help the beleaguered farmer, /16/ it is quite
possible, now that Congress has provided such help, that the judges
who supported the decision below will reconsider their position. /17/
Further, the decision of the court of appeals is an aberration.
The court clearly departed from settled law. The courts to consider
the absolute priority rule after this decision have refused to follow
the Eight Circuit's reasoning. Although the logic of the decision
below extends to any labor-intensive business, one court has read the
opinion as only applying to the farm context. See In re Wolf, 61
Bankr. 1010, 1012-1013 (Bankr. N.D. Iowa 1986). A second court has
rejected its holding outright. See In re Stegall, supra. Moreover,
we doubt that even the Eight Circuit will adhere to this decision in
the long run. Five of the court's 10 judges are on record as
regarding the issue as one deserving en banc consideration, and the
sixth vote could well be forthcoming the next time the issue comes
before the court. /18/ Thus, it is quite possible that the only
impact of the decision below will be to emasculate the absolute
priority rule for purposes of this case. If the Eight Circuit adheres
to this decision in a future case, or another court of appeals follows
it, there will be time then for this Court to review the matter.
CONCLUSION
The Court may wish to consider summary reversal on the absolute
priority issue. Otherwise, the petition for a writ of certiorari
should be denied.
Respectfully submitted.
CHARLES FRIED
Solicitor General
RICHARD K. WILLARD
Assistant Attorney General
LOUIS R. COHEN
Deputy Solicitor General
ROY T. ENGLERT, JR.
Assistant to the Solicitor General
ROBERT S. GREENSPAN
ROBERT K. RASMUSSEN
Attorneys
MAY 1987
/1/ The court also held that the district court placed erroneous
values on respondents' farmland for adequate protection purposes, even
if it was not error for the district court to value the land as of the
date the petition was filed instead of the date that the secured
creditor could have sold it (Pet. App. A13). The court then ruled
that, because they were farmers, respondents could make adequate
protection payments when the crops are harvested rather than every
month (id. at A14). Finally, the court overturned the district
court's holding that 1985 crops could not provide adequate protection
(ibid.).
/2/ Section 1129(b) provides in pertinent part:
(1) * * * the court * * * shall confirm the plan * * * if the
plan does not discriminate unfairly, and is fair and equitable
(to dissenting creditors).
(2) For the purpose of this subsection, the condition that a
plan be fair and equitable * * * includes the following
requirements:
* * * * *
(B) With respect to a class of unsecured claims --
(i) the plan provides that each holder of a claim of such
class receive or retain on account of such claim property of a
value, as of the effective date of the plan, equal to the
allowed amount of such claim; or
(ii) the holder of any claim or interest that is junior to
the claims of such class will not receive or retain under the
plan on account of such junior claim or interest any property.
/3/ Petitioners assert (Pet. 17-20) that 28 U.S.C. 46(c) required
the court of appeals to grant rehearing en banc because five of nine
nonrecused judges voted for such rehearing. This Court, however,
determined in Shenker v. Baltimore & O.R.R., 374 U.S. 1, 4-5 (1963),
that a court of appeals could deny rehearing en banc when four of sic
participating judges voted for rehearing, with two abstentions.
Petitioners attempt (Pet. 19) to distinguish Shenker because in this
case Judge Magill did not abstain but recused himself, but Shenker's
reasoning admits of no such distinction. The Shenker Court reiterated
(374 U.S. at 4-5) the observations in Western Pacific R.R. Corp. v.
Western Pacific R.R. Co., 345 U.S. 247, 250 (1953), that Section 46(c)
is "not addressed to litigants (but) to the Court of Appeals" and is
"a grant of power" but "goes no further." Given the "discretion"
recognized in Shenker, 374 U.S. at 5, and this Court's reluctance to
regulate "the internal administration of the Courts of Appeals"
(ibid.), there is nothing inappropriate in the existence of different
practices in the court below and in the Fourth Circuit (see Arnold v.
Eastern Air Lines, 712 F.2d 899 (4th Cir.), cert. denied, 464 U.S.
1040 (1983); see also 4th Cir. R. 35(b)).
/4/ Commentaries advocating this interpretation include Baird &
Jackson, Corporate Reorganizations and the Treatment of Diverse
Ownership Interests: A Comment on Adequate Protection of Secured
Creditors in Bankruptcy, 51 U. Chi. L. Rev. 97, 115-116 (1984), and
Comment, Compensation for Time Value as Part of Adequate Protection
During the Automatic Stay in Bankruptcy, 50 U. Chi. L. Rev. 305
(1983).
/5/ This position is advocated in Note, "Adequate Protection" and
the Availability of Postpetition Interest to Undersecured Creditors in
Bankruptcy, 100 Harv. L. Rev. 1106 (1987).
/6/ For a similar position, see Nimmer, Secured Creditors and the
Automatic Stay: Variable Bargain Models of Fairness, 68 Minn. L. Rev.
1, 18 (1983).
/7/ Arguably, Congress intended -- at least with respect to
diminution in value of the secured property, if not also with respect
to the lost opportunity to reinvest sale proceeds -- that creditors
receive adequate protection for the entire postpetition period, even
though, had bankruptcy not intervened, there would have been delay and
the possibility of loss before a foreclosure sale. Pet. 15-16; Am.
Council of Life Ins. Br. 12-14; Am. Coll. of Real Estate Lawyers Br.
33-36.
/8/ In some cases in which the reorganization fails, the debtor
will then go into liquidation under Chapter 7 of the Bankruptcy Code,
11 U.S.C. (& Supp. III) 701 et seq. In such cases, the trustee may
then have the power under 11 U.S.C. 725 to turn the property over to
the secured creditor directly, pretermitting state foreclosure
proceedings.
/9/ We note, however, that the timing issue arises in contexts
other than farm reorganization when either state law or market
realities delay foreclosure on real estate. See, e.g., In re Bessey,
65 Bankr. 638, 644 (Bankr. S.D. Cal. 1986); In re Landsea Marketing,
Inc., 53 Bankr. 436 (Bankr. C.D. Cal. 1985); In re Woodland Hills
Village Development Corp., 54 Bankr. 77 (Bankr. D. Md. 1985); In re
Independence Village, Inc., 52 Bankr. at 730-731; In re Bear Creek
Ministorage, Inc., 49 Bankr. at 457-458 & n.9; In re South Village,
Inc., 25 Bankr. at 996 n.14.
/10/ To the extent that petitioners' claims exceeded the value of
their collateral, they were entitled to be treated as unsecured
creditors (11 U.S.C. 506(a)).
/11/ The absolute priority rule has its origins in this Court's
decision in Northern Pacific R.R. v. Boyd, 228 U.S. 482 (1913). There
Boyd, an unsecured creditor, had been given no interest in a
reorganized firm while the shareholders of the predecessor firm
received an interest in it. This Court held that such action violated
Boyd's rights. The shares of the new corporation were "a right of
property out of which the creditors were entitled to be paid before
the stockholders could retain it for any purpose whatever" (228 U.S.
at 508). In other words, Boyd had an absolute right to be paid in
full before any of the equity holders of the former enterprise were
allowed to participate in the new one.
/12/ The court of appeals sought to justify its interpretation by
relying on the phrase "money's worth" in this passage. It is clear,
however, that the full import of this passage is to limit owner equity
participation to cases where the owner has infused the debtor with
fresh capital, such as cash or bonds.
/13/ The court of appeals also justified allowing respondents to
participate in the reorganization on the grounds that they had "farm
operation and management skills" (Pet. App. A24), that their
participation would preserve the farm's going-concern value (id. at
A24-A25), and that "(a)ny other view would deny to most farmers the
opportuhity to take advantage of the reorganization provisions of the
Bankruptcy Act" (id. at A25). The first two justifications were
expressly disapproved by this Court in Los Angeles Lumber. See 308
U.S. at 123 n.16 (approving court of appeals decision not allowing
participation based on supposed management skills); id. at 123 ("fact
that (creditors) might fare worse as a result of a foreclosure and
liquidation than they would by taking a debtor's plan (has) no
relevant bearing on whether a proposed plan is 'fair and equitable'").
The third merely argues for abrogation of the absolute priority rule.
/14/ This new provision, however, appears on its face not to apply
to proceedings begun before the effective date of the Act (November
26, 1986). 1986 Act Section 302(a) and (c), 100 Stat. 3119. But see
In re Big Dry Angus Ranch, Inc., 69 Bankr. 695 (Bankr. D. Mont. 1987)
(allowing conversion of pending Chapter 11 case to Chapter 12); In re
Erickson Partnership, 68 Bankr. 819 (Bankr. D.S.D. 1987) (same).
/15/ The new law has other pro-farmer features. It specifically
allows adequate protection only to offset decline in value of the
collaterial. 100 Stat. 3107-3108 (to be codified at 11 U.S.C. 1205);
see also In re Rennich, 70 Bankr. 69 (Bankr. D.S.D. 1987). It also
dilutes the absolute priority rule as it applies to secured creditors.
Compare 11 U.S.C. (Supp. III) 1129(b)(2)(A) with 100 Stat. 3111 (to
be codified at 11 U.S.C. 1225(a)(5)). At least one court, however,
has suggested that some of the pro-farmer features of Chapter 12, to
the extent they are applied retrospectively, may work an
unconstitutional taking without just compensation of the property of
secured creditors. See In re Ray, 70 Bankr. 431 (Bankr. E.D. Mo.
1987).
/16/ See also In re Stegall, 64 Bankr. 296, 300 (Bankr. C.D. Ill.
1986) ("We understand the motivation behind the majority opinion in
Ahlers. * * * Nevertheless, the solution (to farmers' plight)
proposed by the Ahlers majority is contrary to the Bankruptcy Code and
a long line of case law.").
/17/ If the decision below were to be adhered to and followed,
however, it could not logically be limited to the farm bankruptcy
context. Virtually any debtor in reorganization could claim that his
labor, experience, and expertise constitute "money's worth" entitling
him to avoid the absolute priority rule, and the rule would be
emasculated in farm and nonfarm contexts alike.
/18/ Indeed, petitioners recognize that, "(i)n most situations,
this Court might reasonably conclude to allow the Court of Appeals
majority to overrule this minority decision in due course" (Pet. 18).